How Promontory Financial Became Banking's Shadow Regulator

Magazine PreviewThis story will appear in the April issue of American Banker Magazine.

In 2001, Eugene Ludwig opened a consulting business with little more than a secretary and a thick rolodex of contacts from his days as a top banking regulator. An astute, driven college friend of Bill Clinton's, Ludwig had presided over a momentous five years for banking as comptroller of the currency. Even as he prodded banks to embrace fair lending and modernize their risk management, he championed their push into securities markets and used preemption to pry state regulators off the OCC's turf.

At the heart of his new firm's business model was the prescient premise that as banks diversified into new states and markets they would be concentrating their exposure to Washington's oversight. Navigating regulations-and the aims of the people who made them-would become as vital to modern banking as managing credit risk.

"I think it is insane not to follow those rules with vigor," Ludwig says. "First, more than on balance they're designed to make the system and institutions better and safer. Second, they're the law."

With close to 400 employees and some 1,400 consulting engagements under its belt, Promontory Financial Group has built a shadow network between banks and regulators. The firm is a sort of ex-regulator omnibus, capable of forecasting, mimicking and occasionally even substituting for the financial industry's supervisors.

For those who view regulators and the industry as generally reasonable and well intentioned, that work might be viewed as a blessing. But the expertise and impressive connections that shaped Promontory's success are now threatening its reputation, and potentially its future business.

Promontory's strengths, and its connections, stem directly from Ludwig. Clients and rivals alike profess admiration for his intelligence, good cheer and tireless work ethic, and former colleagues from in and out of government have flocked to work for him. He has set out to build an auxiliary, if not better, private-sector regulator, one that-for a fee-will whip problem banks into better shape.

"Promontory in general and Gene in particular know the banking industry very well. They know the problems that the industry has, they know regulation extremely well, and they've hired a lot of first-class people," says Bob Wilmers, CEO of M&T Bank, which brought in Ludwig to speak to its board in November.

Sandy Weill is another fan. The former Citigroup CEO, who founded an education nonprofit where Ludwig is a board member, was Citi's nonexecutive chairman when the bank hired Promontory to overhaul its Japanese business (although Weill says he was not involved in those discussions).

"If one looks around at who can really be helpful as an outside influence on making this industry better ... I think he and his company do that incredibly well," Weill says.

Ludwig is quick to argue that Promontory's influence and its deployment of well-connected staff members extends only in one direction.

"We don't lobby-it's not our business. We do the opposite of influencing government. We try to influence the private sector in terms of what the government wants it to do," he says. (Ludwig did register as a lobbyist for Countrywide after being hired to advise the mortgage giant on its dwindling options in late 2007, though there's no record he performed any advocacy work.)

Indeed, while Promontory could easily bring a client's concern to a high-level regulator's attention, former employees and industry insiders say that any client making such a request doesn't understand the value of the firm. Promontory knows how to please regulators, they say, but it doesn't try to cajole them.

Ludwig says he considers himself a bank doctor, one who specializes in emergency medicine but prefers providing long-term care.

"In the early days, we analyzed the problem, made recommendations, and then left," he says. "Increasingly we found it's more efficacious to be around to implement the recommendations and then order a back test."

The firm's popularity and prolific work has created a powerful network effect: given the breadth of its client list, it can spot emerging regulatory trends.

"They can say, 'We know you've never been criticized for doing something this way in your last three [Bank Secrecy Act] examinations, but you're going to get criticized for it on the next one,'" says H. Rodgin Cohen, a partner at Sullivan & Cromwell and an occasional recipient of referrals from Ludwig's firm. "Promontory is extremely scrupulous in not divulging what's happening at any other institution, but they've got a wealth of experience."

Promontory's outsized success has raised fears that consultants have usurped roles best played by regulators themselves. Chosen as the foremost consultant in the OCC's aborted independent foreclosure reviews, Promontory was an obvious beneficiary of regulators' disastrous and expensive effort to outsource the solution to the foreclosure debacle.

JOIN THE DISCUSSION

SEE MORE IN

IN PICTURES

As U.S. auto lending has boomed, the industry — especially its subprime sector — has become a growing target for a slew of prosecutors and regulators. Here are seven government agencies to keep an eye on.

(Image: Bloomberg News)

Comments (2)

Has cronyism and corruption gone too far? This is an eye-opening article and a poke in the public's eye.
The US regulatory system is something more likely to be seen in Russia than in a fully functioning democracy. When will it ever stop? Today's WSJ shows former SEC chief Mary Schapiro joins Promontory Financial Group, which has built a reputation as a shadow regulator by hiring scores of former government officials. Promontory already has former SEC chairman Arthur Leavitt on its advisory board.

It also has dozens of former senior and top officials from the Fed, OCC, SEC, Treasury and FDIC. It reportedly pays these folks upwards of $1.0 million in salaries compared to their previous government salaries that topped out at $175,000.

How Promontory can get a "contract" by the government whereby it reaped more than a billion dollars for its ill-managed mortgage review efforts at three banks is unimaginable. The OCC had to put a stop to the reviews after it realized that the mortgage reviews were a catastrophe in the making, reportedly given that each loan reviewed by Promontory was costing $10,000 a piece. Heck, the professional independent mortgage review teams charge only $450 per loan that is reviewed and graded to determine if it should be securitized by Wall Street.

What government regulatory agency does not have a hand in helping Promontory and team to win and prosper?

Even FDIC Chairman Marty Gruenberg's son is a manager at Promontory, responsible for heading up ill-fated mortgage review teams composed of some 250 employees. He had no relevant experience to supervise such mortgage reviewers but this did not stop Promontory. Could this be due to political connections are more important than knowledge and practical experience? Certainly appears so.

It will be telling if there is enough uproar to cause Congress to hold hearings as to how Promontory was allowed to rip-off the three banks (and indirectly, harmed homeowners) to the tune of a billion or more. Where are the investigative stories by the Washington Post and New York Times? Could the lack of stories be indicative of a "Woodward-gate" at play whereby Promontory can unduly influence the press, with some assistance from politicos? Looks to be the case, does it not? Otherwise, WaPo and the NYT would be all over this.

I had one well known lawyer tell me that I should stop exposing the system and lay calm so that I, too, can go reap the rewards by perhaps working for Promontory or some other bank consultancy. If I were smart and greedy, I should contact Promontory to tell them I am interested in working for them. Or, to provide legitimacy, hire a lawyer to approach Promontory with an "offer."

If the government is corrupt and one cannot fight corruption, then why not join them? Promontory or other consultancies, are you listening?

Posted by Dwihas3 | Tuesday, April 02 2013 at 12:02PM ET

I can think of many terms to describe Promontory Financial Group, headed by former Comptroller of the Currency, Eugene Ludwig, but "shadow regulator" is certainly not one of them.
Its self-enrichment in the latest mortgage servicing review fiasco would not indicate the type of industry or social benefit one might expect from a regulator.
The fees received by a handful of well-connected consulting firms, including Promontory, consumed more than half of the $8.5 billion settlement, leaving less than $3.8 billion to be distributed to homeowners improperly foreclosed upon.
Representative Carolyn B. Maloney (D-NY) said, "It's clear from the foreclosure settlement that oversight over consultants was inadequate and the review process was deeply flawed," and she is pressing regulators to detail how the consultants were paid.
In one case, the OCC actually replaced a consulting firm it had approved for billing the settlement for reviewing some of the same loan pools it had reviewed in a previous engagement.